With policy thrust, China’s yuan steps out

Central bank expands its currency internationalization

WangZiwu

BEIJING (Caixin Online) — China’s push for international acceptance of the yuan has expanded in recent weeks to embrace three, synchronized steps: currency outflow to overseas investments, offshore yuan market in Hong Kong, and backflows of yuan to China as foreign investment.

The central bank, which is leading the government’s go-global campaign for the Chinese currency, expanded a pilot program for yuan-based settlement for cross-border trade Jan. 13 with the release of a related measure covering foreign direct investments by Chinese companies.

Meanwhile, measures to prevent speculation in interest and exchange rates recently kicked off in Hong Kong.

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And in anticipation of the third go-global step, which is still in the planning phase, a source close to the central bank said research is underway for a program that would allow yuan-denominated investment in China by foreign firms to facilitate currency back-flow.

The source said the research has involved the Ministry of Commerce, National Development and Reform Commission, State Administration for Industry and Commerce, and Ministry of Finance. At best, the source said, the government’s back-flow policy could be finalized in about six months.

One overseas investor said a policy allowing the use of yuan for foreign direct investment in China would simplify what’s now a complex currency exchange process. However, the investor added, the yuan is now in short supply, and “there are few channels for foreign investors to access yuan funds.”

Policy pains

The central bank’s decision to expand the trade settlement project while adding the anti-speculator step and studying back-flow policy came after China’s annual quota for yuan conversions for cross-border trade settlements assigned to the Bank of China-Hong Kong was suddenly exhausted last October.

Immediately after that incident, officials from the Hong Kong Monetary Authority (HKMA) sat down with counterparts at the central bank and China Securities Regulatory Commission.

Central bank officials stressed that their offer to allow yuan funding in Hong Kong at a favorable exchange rate was a special arrangement designed to support the overseas-Hong Kong-mainland trade, according to the source.

But speculators, including major financial institutions hoping to benefit from future appreciation of the yuan, have been reluctant to let go of their supplies of the Chinese currency. Many are still waiting for a chance cash in by transferring yuan back to the mainland.

To deflate these speculative expectations, Chinese authorities decided to encourage overseas markets for yuan, after the currency circulates in Hong Kong. Companies have therefore stepped up their use of yuan accounts in Hong Kong since July, when China started allowing the use of yuan for trade settlements worldwide.

Yuan-denominated bank deposits in Hong Kong have grown to about 300 billion yuan ($45.6 billion) today from 70.8 billion yuan in March 2010, according to HKMA. And demand for more yuan remains high, the agency said.

The central bank source said, however, that yuan-holders in Hong Kong tend to hold the currency rather than use it for trade. Hong Kong investors searching for yuan-denominated products, meanwhile, can find nothing more than bonds.

The next step, which HKMA welcomed, was the Jan. 13 ruling to further promote the offshore yuan market in Hong Kong, said Norman Chan, chief executive of HKMA. Now, approved companies can use yuan to establish or buy an overseas business, or acquire a business stake, controlling rights, or management power through incorporation, cash or share purchases.

“The total volume of Chinese companies’ outbound [foreign direct investment] is expected to grow at an annual rate of 40% to 50%,” Ho said. “Given the fact that nearly 90% of China’s outbound direct investments are made in emerging markets, the rollout of this new pilot will help meet growing demand for yuan in cross-border trade in emerging markets.”

The latest measure also raised new concerns about hot money. For example, some worry yuan funds that leave China will no longer by subject to Beijing’s regulatory control.

The source close to the central bank downplayed these concerns, however, noting few overseas markets support yuan investments, so that any currency used overseas would eventually come home.

There’s no reason to fear yuan hoarding by investors seeking to benefit from the currency’s appreciation, the source said. “Even if the yuan appreciates 3% a year, the yield would still be far lower than that from investing in U.S. Treasurys and other products,” the source said.

Currently, the yuan is used for deposits, loans and some bond purchases in offshore markets. “Even if all the money were fully deregulated, the multiplier wouldn’t be large,” said a source close to the central bank. “The amount of currency coming from overseas markets will be limited.”

And if these yuan funds are brought back to China, he said, they should not be called hot money.

Indeed, capital inflow is not the same as hot money, agreed Liu Wei, general affairs director at the State Administration of Foreign Exchange. Besides, China still enforces capital controls through, for example, policies designed to curb inflows of arbitrage-driven, speculative capital.

Hong Kong policy makers are closely watching the central bank’s moves in the hot money arena out of concern that their offshore yuan market may be challenged by Shanghai, which hopes to become an international financial hub.

“How successfully Hong Kong can reach its goal of shaping itself into a yuan offshore center for trade largely depends on how well and fast Shanghai can transform itself into an onshore center,” said Fang Xinghai, director general of the Shanghai Financial Services Office, in a speech recently at the Asian Financial Forum. See this report at Caixin Online.

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